Even some of the best-run companies in the world can make mistakes. McDonald's (NYSE:MCD) started 2012 betting on a turn in the economy and consumer sentiment, and tried to move customers up-market from its value offerings. That didn't work, and the stock lagged for the year. While McDonald's has retrenched around value and continues to deliver impressive profits, investors' perennial support for this company rarely allows it to get very cheap.
Fourth Quarter Results Underline the Company's Capabilities
The results McDonald's reported for the fourth quarter weren't exactly barn burners, but that's never really expected now for a company this large. That said, the results were pretty good in their own right.
Reported revenue increased almost 2% this quarter, with company-owned stores up 1.6% and franchised stores up 2.6%. Comps were muted, up just 0.1% across the global system, with surprisingly good results in the U.S. (up 0.3% for the quarter and 0.9% for December) offsetting weakness in Europe (-0.6%) and China (-0.9%).
Margins were pretty decent on balance. Gross margin declined a bit (about 60 basis points) on higher franchise occupancy expenses, but operating income increased 4% and operating margin expanded on lower general and administrative costs. Company-operated restaurant margins did decline almost a point from last year, but at nearly 18% they still compare quite well with other quick-service restaurants (QSR) such as Burger King (NYSE:BKW) and Wendy's (Nasdaq:WEN).
Growth May Be Tough, At Least to Start the Year
McDonald's may find it tough to get off to a roaring start in 2013. Comps for the first quarter of 2012 were quite strong, and management indicated that January is likely to be negative. There's a sharp drop once April rolls around, however, so this could be a case where McDonald's looks stronger as the year rolls on.
Still, we're not talking about a torrid growth story anymore. McDonald's may pick up a little extra business from Yum Brands' (NYSE:YUM) PR problems in China, but Europe is still in a tough situation and McDonald's has a large exposure there. The U.S. will also be challenging - companies such as Jack In The Box (Nasdaq:JACK) and Sonic (Nasdaq:SONC) aren't really a threat, and Chipotle (NYSE:CMG) is slowing, but McDonald's owns such a large piece of the QSR pie that it will be tough to stand out.
But "tough" doesn't mean impossible. The company has reemphasized its value-based marketing, and new products such as the CBO and McBites show the benefits of greater international integration (both products were developed outside of the U.S.). Moreover, CEO Thompson has talked in the past of an increased commitment to introducing more nutritious food options. I'm skeptical that that's what McDonald's core customer base wants; but it's worth a try, and McDonald's has shown that it's not afraid to try new offerings.
The Bottom Line
McDonald's is a good core defensive holding, and that's part of the problem. Because the positive attributes of McDonald's are so well understood by the market, it's rarely cheap. So, too, today. Even if McDonald's can grow its free cash flow at a high single-digit rate over the long term, it's no better than fairly priced today. While there are worse things than owning high-quality stocks at a fair price, investors buying today need to be willing to hold for awhile and content with gradual appreciation from these levels.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.